[Congressional Record Volume 154, Number 157 (Monday, September 29, 2008)]
[House]
[Pages H10631-H10633]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




     THE DEFEAT OF THE EMERGENCY ECONOMIC STABILIZATION ACT OF 2008

  (Ms. KAPTUR asked and was given permission to address the House for 1 
minute and to revise and extend her remarks.)
  Ms. KAPTUR. Madam Speaker, this was an amazing day in the Congress of 
the United States. The American people were actually heard, and fear 
was put on the shelf as we stopped hasty action that Wall Street 
powerhouses had attempted to ram through this Congress. It was a 
sobering day. It was an exhausting day. Now we have to get to work to 
create a new moment: to draft legislation on a bipartisan basis that is 
responsible, that is rigorous and that meets the real needs.
  This includes securities and exchange reform legislation to expand 
credit flows. The SEC and bank regulators must act immediately to 
suspend the fair value accounting rules; they must clamp down on abuses 
by short sellers, and they must withdraw the Basel II capital rules. 
These will go a long way to expanding credit flows at the local level.
  We have to stabilize our housing markets on Main Street, and we have 
to reform the regulatory process and investigate the wrongdoers who 
brought America and the American people to this juncture.
  We have to fund the FBI to go after those who have exhibited 
malfeasance, accounting fraud, who have used abusive practices, and who 
have made billions doing it.
  I want to thank the American people and this Congress for doing what 
was right, not what was hasty.

                         Regulating Wall Street

                         (By William M. Isaac)

       The Fed's decision to open the discount window to Wall 
     Street firms, and to subsidize the takeover of Bear Stearns, 
     requires that we rethink the regulation of Wall Street. How 
     we resolve the issues will have profound effect on our 
     financial markets for years to come.
       Before attempting to come up with answers, we need to make 
     sure we know and understand the questions. I will try to 
     identify the important ones.
       A. Who Gets Access to the Safety Net? Under What 
     Circumstances? What Price Do They Pay? The federal safety net 
     (i.e., the ability to borrow from the Fed and to offer 
     insured deposits) was created to promote stability in the 
     banking and thrift industries, and the cost is borne by banks 
     and thrifts. The deposit insurance fund now exceeds $50 
     billion, and each year the Fed pays to the Treasury billions 
     of dollars of profits earned in part from interest-free 
     reserves maintained by banks.
       If we expand the safety net, which firms should be 
     included--investment banks, hedge funds, leveraged buyout 
     firms, insurance companies, others? How will we draw the 
     line--size of firm, inter-connections to other firms, harm a 
     failure would cause to consumers or businesses, the potential 
     impact of a failure on financial stability?
       If non-banks are granted access to the safety net, will 
     they be required to help pay cost? Would it be fair to banks 
     and thrifts to have invested billions per year in the safety 
     net for much of the past century to suddenly allow non-banks 
     to obtain the benefits of the safety net? What would be the 
     competitive effects on banks and thrifts?
       B. Who Will Regulate Our New Universe of Safety Net Firms? 
     Treasury argues that we need to revamp the regulation of 
     financial firms in view of the new world of finance in which 
     commercial banks, thrifts, investment banks, insurance 
     companies, and others perform many of the same functions. It 
     is suggested that we need to consolidate the regulators while 
     designating a single ``market stability'' regulator.
       I would argue that the genius of the American system of 
     government is the diffusion of government power. We do not 
     believe in centralized planning, and we rely heavily on 
     checks and balances.
       One of the clearest lessons of the S&L crisis of the 1980s 
     is that we must have an independent deposit insurance agency 
     armed with the full array of examination and enforcement 
     powers. The former FSLIC, which insured deposits at S&Ls, was 
     a toothless agency operating as a subsidiary of the primary 
     regulator. The failure to provide that check on the S&L 
     industry was an important contributing factor to a taxpayer 
     loss of some $150 billion. Are we prepared to go down that 
     path again in our pursuit of a tidy organizational chart?
       We currently have at least four agencies heavily focused on 
     maintaining stability in the financial markets--the Fed, the 
     SEC, the FDIC, and Treasury. Do we really believe that having 
     a single agency fretting about market stability will be an 
     improvement? If so, which agency has been proven to have such 
     all-knowing vision and wisdom?
       The major problem confronting our financial system for the 
     past year is the collapse in the residential real estate 
     markets. Did the banking agencies and Treasury not notice 
     that unregulated mortgage loan brokers were sprouting up 
     everywhere, that securitizations were providing unprecedented 
     liquidity to mortgage markets, that

[[Page H10632]]

     home loan underwriting standards were deteriorating, and that 
     home prices were skyrocketing? Did the agencies seek 
     more information or take actions to dampen the frenzy, 
     were they rebuffed, or did they not appreciate the 
     potential problems?
       Take a look at the public debate while the real estate 
     bubble was building. You will find the Fed and Treasury 
     touting the Basel II capital regime as the way to make more 
     precise calculations of how much capital was really required 
     in our banks. It was argued that this would allow our large 
     banks to reduce their capital to international norms, or 
     about half the U.S. level. Does that sound like folks who 
     were concerned in the slightest about a bubble in real 
     estate?
       Thankfully, the FDIC, the OTS, and a few Congressional 
     leaders fought against eliminating the minimum capital 
     requirement for U.S. banks. As bad as things might be right 
     now, how much worse they would be if Basel II had breezed 
     through without a minimum capital standard and our major 
     banks had leveraged their balance sheets even further during 
     the past few years?
       One final question to ponder as we debate our future: Would 
     we be better served by a messy, contentious, and some times 
     frustrating regulatory system that moves cautiously or by a 
     highly efficient system that runs with alacrity off the 
     nearest cliff?
       Would it be more appropriate to legislate that non-banks 
     develop and pay for their own safety net? Should we impose 
     new standards to reduce greatly the odds that non-banks will 
     ever need to use the safety net again? Might it be 
     appropriate to enact tough ground rules restricting the 
     ability of the Fed to lend to non-bank firms in the absence 
     of a national emergency? Should the Fed be allowed to act 
     unilaterally?
       If non-bank firms are included in the bank-funded safety 
     net, what sort of regulation will we impose on them? Will it 
     be equivalent to the regulation of banks, i.e., capital 
     regulation, liquidity requirements, examinations, reporting 
     requirements, compliance regulations, limitations on loans to 
     affiliates and officers and directors, restrictions on 
     ownership and permissible activities, lending limits, and a 
     full range of regulatory enforcement powers?
       If non-bank firms are included in the bank-funded safety 
     net and then fail, how will the failures be handled? Will 
     they be subject to the receivership powers of the FDIC? If 
     not, who will administer the receivership?
       Do we want our central bank providing liquidity and also 
     handling failures? We used to have a comparable system in the 
     S&L industry with disastrous results.
       If we go down the path of comparable regulation of 
     commercial banks and investment banks, will investment banks 
     be able to continue their high-risk underwriting and 
     investment activities so vital to capitalism? If not, will 
     they remain in the U.S. or move their headquarters to London 
     or Dubai?
                                  ____


                    How To Save the Financial System

                         (By William M. Isaac)

       I am astounded and deeply saddened to witness the senseless 
     destruction in the U.S. financial system, which has been the 
     envy of the world. We have always gone through periods of 
     correction, but today's problems are so much worse than they 
     needed to be.
       The Securities and Exchange Commission and bank regulators 
     must act immediately to suspend the Fair Value Accounting 
     rules, clamp down on abuses by short sellers, and withdraw 
     the Basel II capital rules. These three actions will go a 
     long way toward arresting the carnage in our financial 
     system.
       During the 1980s, our underlying economic problems were far 
     more serious than the economic problems we're facing this 
     time around. The prime rate exceeded 21%. The savings bank 
     industry was more than $100 billion insolvent (if we had 
     valued it on a market basis), the S&L industry was in even 
     worse shape, the economy plunged into a deep recession, and 
     the agricultural sector was in a depression.
       These economic problems led to massive credit problems in 
     the banking and thrift industries. Some 3,000 banks and 
     thrifts ultimately failed, and many others were merged out of 
     existence. Continental Illinois failed, many of the regional 
     banks tanked, hundreds of farm banks went down, and thousands 
     of thrifts failed or were taken over.
       It could have been much worse. The country's 10-largest 
     banks were loaded up with Third World debt that was valued in 
     the markets at cents on the dollar. If we had marked those 
     loans to market prices, virtually every one of them would 
     have been insolvent. Indeed, we developed contingency plans 
     to nationalize them.
       At the outset of the current crisis in the credit markets, 
     we had no serious economic problems. Inflation was under 
     control, GDP growth was good, unemployment was low, and there 
     were no major credit problems in the banking system.
       The dark cloud on the horizon was about $1.2 trillion of 
     subprime mortgage-backed securities, about $200 billion to 
     $300 billion of which was estimated to be held by FDIC-
     insured banks and thrifts. The rest were spread among 
     investors throughout the world.
       The likely losses on these assets were estimated by 
     regulators to be roughly 20%. Losses of this magnitude would 
     have caused pain for institutions that held these assets, but 
     would have been quite manageable.
       How did we let this serious but manageable situation get so 
     far out of hand--to the point where several of our most 
     respected American financial companies are being put out of 
     business, sometimes involving massive government bailouts?
       Lots of folks are assigning blame for the underlying 
     problems--management greed, inept regulation, rating-agency 
     incompetency, unregulated mortgage brokers and too 
     much government emphasis on creating more housing stock. 
     My interest is not in assigning blame for the problems but 
     in trying to identify what is causing a situation, that 
     should have been resolved easily, to develop into a crisis 
     that is spreading like a cancer throughout the financial 
     system.
       The biggest culprit is a change in our accounting rules 
     that the Financial Accounting Standards Board and the SEC put 
     into place over the past 15 years: Fair Value Accounting. 
     Fair Value Accounting dictates that financial institutions 
     holding financial instruments available for sale (such as 
     mortgage-backed securities) must mark those assets to market. 
     That sounds reasonable. But what do we do when the already 
     thin market for those assets freezes up and only a handful of 
     transactions occur at extremely depressed prices?
       The answer to date from the SEC, FASB, bank regulators and 
     the Treasury has been (more or less) ``mark the assets to 
     market even though there is no meaningful market.'' The 
     accounting profession, scarred by decades of costly 
     litigation, just keeps marking down the assets as fast as it 
     can.
       This is contrary to everything we know about bank 
     regulation. When there are temporary impairments of asset 
     values due to economic and marketplace events, regulators 
     must give institutions an opportunity to survive the 
     temporary impairment. Assets should not be marked to 
     unrealistic fire-sale prices. Regulators must evaluate the 
     assets on the basis of their true economic value (a 
     discounted cash-flow analysis).
       If we had followed today's approach during the 1980s, we 
     would have nationalized all of the major banks in the country 
     and thousands of additional banks and thrifts would have 
     failed. I have little doubt that the country would have gone 
     from a serious recession into a depression.
       If we do not halt the insanity of forcing financial firms 
     to mark assets to a nonexistent market rather than their 
     realistic economic value, the cancer will keep spreading and 
     will plunge the world into very difficult economic times for 
     years to come.
       I argued against adopting Fair Value Accounting as it was 
     being considered two decades ago. I believed we would come to 
     regret its implementation when we hit the next big financial 
     crisis, as it would deny regulators the ability to exercise 
     judgment when circumstances called for restraint. That day 
     has clearly arrived.
       Equally egregious are the actions by the SEC in recent 
     years lifting the restraints on short sellers of stocks to 
     allow ``naked selling'' (shorting a stock without actually 
     possessing it) and to eliminate the requirement that short 
     sellers could sell only on an uptick in the market.
       On top of this, it is my understanding that short sellers 
     are engaged in abuses such as purchasing credit default swaps 
     on corporate bonds (essentially bets on whether a borrower 
     will default), which lowers the price of the bonds, which in 
     turn causes the price of the company's stock to decline 
     further. Then the ratings agencies pile on and reduce the 
     ratings of a company because its reduced stock price will 
     prevent it from raising new capital. The SEC must act 
     immediately to eliminate these and other potential abuses by 
     short sellers.
       The Basel II capital rules adopted by the FDIC, Federal 
     Reserve, Office of Thrift Supervision and the Comptroller of 
     the Currency last year are too new to have caused big 
     problems, but they must be eliminated before they do. Basel 
     II requires the use of very complex mathematical models to 
     set capital levels in banks. The models use historical data 
     to project future losses. If banks have a period of low 
     losses (such as in the mid-1990s to the mid-2000s), the 
     models require relatively little capital and encourage even 
     more heated growth. When we go into a period like today where 
     losses are enormous (on paper, at least), the models require 
     more capital when none is available, forcing banks to cut 
     back lending.
       As I write this article, I am seeing proposals by some to 
     create a new Resolution Trust Corp., as we did in the 1990s 
     to clean up the S&L problems. The RTC managed and sold assets 
     from S&Ls that had already failed. It was run by the FDIC, 
     just like the FDIC. We needed to create the RTC in the 1990s 
     only because we could not comingle the assets from failed 
     banks with those of failed thrifts, because we had two 
     separate deposit insurance funds absorbing the respective 
     losses from bank and thrift failures.
       I can't imagine why we would want to create another 
     government bureaucracy to handle the assets from bank 
     failures. What we need to do urgently is stop the failures, 
     and an RTC won't do that.
       Again, we must take three immediate steps to prevent a 
     further rash of financial failures and taxpayer bailouts. 
     First, the SEC must suspend Fair Value Accounting and require 
     that assets be marked to their true economic value. Second, 
     the SEC needs to immediately clamp down on abusive practices 
     by short sellers. It has taken a first step in reinstituting 
     the prohibition against ``naked selling.'' Finally, the bank 
     regulators need to acknowledge that the Basel II capital 
     rules represent a serious policy mistake and repeal the rules 
     before they do real damage.

[[Page H10633]]

       We are almost out of time if we hope to eradicate the 
     cancer in our financial system.
                                  ____

       Mr. Isaac, chairman of the Federal Deposit Insurance Corp. 
     from 1981-1985, is chairman of the Washington financial 
     services consulting firm The Secura Group, an LECG company.

               [From the Washington Post, Sept. 27, 2008]

                       A Better Way To Aid Banks

                         (By William M. Isaac)

       Congressional leaders are badly divided on the Treasury 
     plan to purchase $700 billion in troubled loans. Their angst 
     is understandable: It is far from clear that the plan is 
     necessary or will accomplish its objectives.
       It's worth recalling that our country dealt with far more 
     credit problems in the 1980s in a far harsher economic 
     environment than it faces today. About 3,000 bank and thrift 
     failures were handled without producing depositor panics and 
     massive instability in the financial system.
       The Federal Deposit Insurance Corp. has just handled 
     Washington Mutual, now the largest bank failure in history, 
     in an orderly manner, with no cost to the FDIC fund or 
     taxpayers. This is proof that our time-tested system for 
     resolving banking problems works.
       One argument for the urgency of the Treasury proposal is 
     that money market funds were under a great deal of pressure 
     last week as investors lost confidence and began withdrawing 
     their money. But putting the government's guarantee behind 
     money market funds--as Treasury did last week--should have 
     resolved this concern.
       Another rationale for acting immediately on the bailout is 
     that bank depositors are getting panicky--mostly in reaction 
     to the July failure of IndyMac, in which uninsured depositors 
     were exposed to loss.
       Does this mean that we need to enact an emergency program 
     to purchase $700 billion worth of real estate loans? If the 
     problem is depositor confidence, perhaps we need to be 
     clearer about the fact that the FDIC fund is backed by the 
     full faith and credit of the government.
       If stronger action is needed, the FDIC could announce that 
     it will handle all bank failures, except those involving 
     significant fraudulent activities, as assisted mergers that 
     would protect all depositors and other general creditors. 
     This is how the FDIC handled Washington Mutual. It would be 
     easy to announce this as a temporary program if needed to 
     calm depositors.
       An additional benefit of this approach is that community 
     banks would be put on a par with the largest banks, 
     reassuring depositors who are unconvinced that the government 
     will protect uninsured depositors in small banks.
       I have doubts that the $700 billion bailout, if enacted, 
     would work. Would banks really be willing to part with the 
     loans, and would the government be able to sell them in the 
     marketplace on terms that the taxpayers would find 
     acceptable?
       To get banks to sell the loans, the government would need 
     to buy them at a price greater than what the private sector 
     would pay today. Many investors are open to purchasing the 
     loans now, but the financial institutions and investors 
     cannot agree on price. Thus private money is sitting on the 
     sidelines until there is clear evidence that we are at the 
     floor in real estate.
       Having financial institutions sell the loans to the 
     government at inflated prices so the government can turn 
     around and sell the loans to well-heeled investors at lower 
     prices strikes me as a very good deal for everyone but U.S. 
     taxpayers. Surely we can do better.
       One alternative is a ``net worth certificate'' program 
     along the lines of what Congress enacted in the 1980s for the 
     savings and loan industry. It was a big success and could 
     work in the current climate. The FDIC resolved a $100 billion 
     insolvency in the savings banks for a total cost of less than 
     $2 billion.
       The net worth certificate program was designed to shore up 
     the capital of weak banks to give them more time to resolve 
     their problems. The program involved no subsidy and no cash 
     outlay.
       The FDIC purchased net worth certificates (subordinated 
     debentures, a commonly used form of capital in banks) in 
     troubled banks that the agency determined could be viable if 
     they were given more time. Banks entering the program had to 
     agree to strict supervision from the FDIC, including 
     oversight of compensation of top executives and removal of 
     poor management
       The FDIC paid for the net worth certificates by issuing 
     FDIC senior notes to the banks; there was no cash outlay. The 
     interest rate on the net worth certificates and the FDIC 
     notes was identical, so there was no subsidy.
       If such a program were enacted today, the capital position 
     of banks with real estate holdings would be bolstered, giving 
     those banks the ability to sell and restructure assets and 
     get on with their rehabilitation. No taxpayer money would be 
     spent, and the asset sale transactions would remain in the 
     private sector where they belong.
       If we were to (1) implement a program to ease the fears of 
     depositors and other general creditors of banks; (2) keep 
     tight restrictions on short sellers of financial stocks; (3) 
     suspend fair-value accounting (which has contributed mightily 
     to our problems by marking assets to unrealistic fire-sale 
     prices); and (4) authorize a net worth certificate program, 
     we could settle the financial markets without significant 
     expense to taxpayers.
       Say Congress spends $700 billion of taxpayer money on the 
     loan purchase proposal. What do we do next? If, however, we 
     implement the program suggested above, we will have $700 
     billion of dry powder we can put to work in targeted tax 
     incentives if needed to get the economy moving again.
       The banks do not need taxpayers to carry their loans. They 
     need proper accounting and regulatory policies that will give 
     them time to work through their problems.

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